Government regulators could insist that mortgage lenders take significant steps to stem the foreclosure crisis--but so far they've refused to.

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December 10, 2009

At Tuesday’s House Committee on Financial Services hearing titled “The Private Sector and Government Response to the Foreclosure Crisis,” Julia Gordon, senior policy counsel for the Center for Responsible Lending, painted a bleak picture.

According to Gordon, 6 million foreclosures were initiated since 2007. Six-and-a-half million more homes are “at risk” right now–with homeowners more than thirty days behind on their mortgage or already in the foreclosure process. This year, American households will lose $500 billion in equity as a result of foreclosures in their neighborhoods.

“Without significantly more intervention to stop foreclosures, by the time this crisis abates, as many as 13 million families will have lost their homes,” said Gordon.

Laurie Goodman, senior managing director at Amherst Securities, agreed. Goodman said in the third quarter this year over 14 percent of borrowers–7.9 million homeowners–were not making mortgage payments.

“We estimate that approximately 7 million of these 7.9 million homeowners will be forced into vacating their properties,” she said. And that “does not include the 250,000 new borrowers per month who are going delinquent for the first time.”

Goodman said “negative equity”–also known as being “underwater,” owing more on one’s mortgage than the home itself is worth–is “the largest single problem” in the foreclosure crisis. Indeed, 25 percent of homeowners are now underwater.

“Most borrowers don’t default because of negative equity alone,” she said. “Generally, a borrower experiences a change in financial circumstances, misses a payment on their mortgage, and then re-evaluates their financial priorities. If the home has substantial negative equity, they will choose to walk.”

In Goodman’s opinion, the administration’s modification program is “destined to fail” because it doesn’t address negative equity.

According to Gordon, the Department of Treasury’s Home Affordable Modification Program (HAMP) was supposed to help 3 to 4 million borrowers. But after nine months approximately 650,000 homeowners are in a trial modification, and “only a small fraction” of those have received a permanent loan modification.

The modifications fail to take into account the homeowner’s full financial picture–including second liens on a property or credit card debt–and they tend to be reductions of interest rates rather than principal modifications, so the homeowner still faces huge negative equity.

“Servicers generally make most of their money from their monthly servicing fee, which is a percentage of the outstanding loan principle balance, so they don’t want to write down the principle balance,” said Gordon.

Finally, HAMP aims to structure a mortgage payment that is equal to 31 percent of a borrower’s income. But Georgia Democratic Congressman David Scott said that is too much in many cases.

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“In these tough economic times, of soaring unemployment…that monthly income in many cases goes to zero. Is it practical not to be able to have an adjustment in there where we can lower that 31 percent threshold?” asked Scott.

Bruce Marks, a former regulator who is the founder and CEO of the Neighborhood Assistance Corporation of America–a community advocacy and homeownership organization, which had many members at the hearing in bright yellow shirts that read “Sharks Beware” and “Stop Sharks”–said there is an easy way to address the unemployment problem.

“When someone does not have stable income because they are unemployed, do a forbearance agreement,” said Marks. “Lenders have been doing forbearance agreements for many, many years, and they should continue to do that.” A forbearance agreement allows homeowners to not make mortgage payments over a specified period of time and not accrue additional fees and charges.

Even more pressing, however, is the need to force banks to make permanent modifications–including modifications on principals, not just interest rates–in order to keep people in their homes and structure loans so they can be paid over the long haul.

“The administration has to stop pleading, begging and bribing the servicers to do the right thing,” said Marks. “Where is the OCC and the Federal Reserve? Let’s require the servicers and the lenders to stop the foreclosures, to restructure the mortgages and make them affordable.”

Officials from the Treasury Department, Federal Deposit Insurance Corporation (FDIC), and Office of the Comptroller of the Currency (OCC) were on hand to discuss their respective efforts–and they faced some skeptical and angry lawmakers.

“What will we do beyond using the ‘rising tide raising all boats’ theory, which we find fatally flawed, as it relates to some who don’t have boats and who have boats that are not water-worthy? What do we do?” asked Texas Congressman Al Green.

“I’ve been to a lot of these hearings. We have asked a lot of these questions over and over and over again,” said Missouri Congressman Emanuel Cleaver, his voice straining with frustration. “This will be the second holiday season that we’ve been asking these questions. Nothing has happened. Why can’t something happen to these lending institutions who took taxpayer money?”

“We want to know what you’re doing to encourage face-to-face involvement with the borrowers and the servicers,” said California Congresswoman Maxine Waters. “We want to know what you’re doing about principal write-down. What we hear is a lot of talk about how you’re going to encourage the banks. The banks thumb their nose at all of us. They don’t care about what you’re saying.”

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“We’re putting them on notice, and then we will exact penalties of them, and be publicly outspoken about who’s performing well and who’s not,” said Herbert Allison, assistant secretary for financial stability at the Treasury Department. “We’re going to move to the point where we’re disciplining the banks if they don’t perform better than they are today.”

Waters did praise FDIC for the way it handled loan modifications as conservator for the failed IndyMac Bank. Waters said that as a result of that work, she and Chairman Barney Frank had written a letter to the previous administration requesting that FDIC Chair Sheila Bair oversee the loan modification program.

“We are appreciative for what you have shown can be done,” said Waters. “But it appears to me that some of the advice that FDIC should be giving to others…is advice that needs to be shared. And it doesn’t appear that it’s being looked at.”

Her harshest assessment was saved for the OCC. “I don’t get a real sense of what you do,” she said. “You do advisories; you look at what is or is not being doing; and then you issue information that says what should be done, or what could be done. This is not good enough.”

Chairman Frank noted that action to stem foreclosures isn’t just needed for the sake of the homeowners but for the wider economy.

“We’re not simply talking about compassion for individuals,” he said. “Foreclosures create concentric circles of harm, primarily to the individual family, but then to the neighborhood, to the municipality, and to the whole economy because of the widespread dispersion of mortgage-backed securities.”

There was some good news in the hearing. Congresswoman Waters noted that an amendment to HR 4173–the financial reform bill–would provide $3 billion in loans to unemployed people to help them avoid foreclosure. (It will also designate $1 billion for the Neighborhood Stabilization Program for the redevelopment of foreclosed properties as affordable housing.) This amendment was a priority for the Congressional Black Caucus.

But this is a drop in the bucket when one looks at the scope of the crisis.

That’s why so many progressives have pinned their hopes on legislation that would permit bankruptcy judges to modify mortgages, including principals. But the filibustering Senate has already defeated that plan outright once, and it’s likely to thwart it again quicker than you can say Baucus, Nelson, Landrieu and Lincoln.

I had the opportunity to speak with Marks after the hearing about what can be done now.

“Very easy–regulators requiring servicers to do principal reductions. End of story,” said Marks. “You know, they did that under TARP when they said to the institutions–even if you don’t want the money, you’re taking it ’cause there’s a financial crisis. I used to be a regulator…. There are a zillion things you can do to get their attention. Bankruptcy reform is important, but it’s a longer haul. Today, you can say we’re going to do this through the regulators.”